Grow Capital First

Discussion in 'Investment Strategy' started by MTR, 29th Apr, 2016.

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  1. radioactive

    radioactive Well-Known Member

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    Exactly. I was also convinced on capital growth but now I am very sceptical. With median wage around 70K and no income growth how is someone going to pay more to raise the price of a median-priced home in the inner ring? Of course, there will be some people who can afford to pay a premium that will maintain equilibrium, but in general, capital growth sounds way too speculative lacking sustainable fundamentals. Major cities already had its CG at par with global cities.Everyone likes to quote the real estate growth in past 25 years but if you look at 100 years history,there are several decades where real estate returns were negative and history can repeat!
     
    Last edited: 31st Jan, 2019
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  2. Omnidragon

    Omnidragon Well-Known Member

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    Well two things I guess. Picking stocks is like properties. Can often find things that double, triple etc. That said my fund wouldn’t put much in each stock because, as you say, it’s not the right risk profile. But personally I’m happy to put more in if I see something I like
     
  3. Omnidragon

    Omnidragon Well-Known Member

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    Not sure I’ve never been in that position but I watched a show the other day about two brothers in Hk. One was a real estate agent and the other a dentist. At 35 the agent had 7 paid off properties and the dentist had nothing
     
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  4. radioactive

    radioactive Well-Known Member

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    Stock Price is a Function of 3 primary things:

    1. PE Re-Rating (Valuation)
    2. Sustainable Earnings Growth
    3. Dividend Payout



    1) Valuation (PE Ratio’s) are largely a function of 3 primary things

    • Growth Rate of the Company (Opportunity Size)
    • Return on Capital Employed a business can generate
    • Interest Rates (Cost of Capital) and Sentiment (Liquidity)

    2) Sustainable Earnings Growth is again largely a function of 3 things

    • Volume Growth of the Product
    • Price Growth of the Product
    • Margin a business can generate

    3) Dividend Payout is again a function of 2 important things

    • Free Cash Flow a Company can Generate (ROE>Growth)
    • Reinvestment opportunities

    There is nothing more to stock Markets mathematically and the one who understands this understands everything to investing.
     
  5. John_BridgeToBricks

    John_BridgeToBricks Buyer's Agent Business Member

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    Well, in terms of valuing stocks, there is also:

    (a) the present value of future cash flows (earnings);
    (b) a view on the quality of management;
    (c) bench-marking the PE ratio for the sector (retail, vs mining for example).

    So picking quality stocks is not perfectly quantitative as this post suggests, and there is the forward looking component. But yes, this is very useful. Thank you.

    Regarding growth vs income properties. It is still true that you should start with growing your capital base before worrying about income. Then shifting on to cash flow as your portfolio matures and you get older.

    One strategy that I use with clients is "pairing". Ie buying one of each with contrasting characteristics in the same markets. Ie one growth, one yield property, and maintaining balance that way.

    For the yield properties, I would still avoid regional and stick to metro areas. You can still find yield in the cities.
     
  6. MWI

    MWI Well-Known Member

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    Yes greed and fear cause many to lose in investing! A liquidator lawyer told me a story of someone who had net worth of $50M go under, lost all, due to greed, buying more, bigger deals, borrowing more, etc...
     
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  7. sash

    sash Well-Known Member

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    That is a great lesson. Stick to what you know well...and sit on your hands when required. Slow and steady always wins the race....;)
     
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  8. euro73

    euro73 Well-Known Member Business Member

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    The last 25 years - well the 25 years from 1990 -2015 at least, were all deregulated years. Really, they were the golden age of resi property investing. But I wonder how many readers properly understand what facilitated it.

    Actuals , combined with massive rate reductions and strong increases to household incomes ( wage growth and double income families becoming the norm) across those 25 years, equated to massive borrowing power increases for the majority. Anyone denying this is either ignorant or deceitful.... and the borrowing power increases fed by the "actuals" policies then fed the trajectory at which resi prices were able to rise . Again , anyone denying this is either ignorant or deceitful.

    Then this was compounded by IO being available for as long as you wished over those same 25 years , because it equated to zero holding cost issues. This also fed the trajectory at which resi prices were able to rise

    So borrowing capacity kept rising because each rate cut was the same as a pay rise( because of "actuals" ) , and IO never impacted anyone's borrowing capacity adversely . And because rates fell consistently across those 25 years , borrowing capacity was almost always improving, year in and year out ( except for an 18-24 month period leading up to the 2007 election- where coincidentally prices also corrected...funny that) so prices were almost always climbing.....and because it was so easy to see equity gains quickly and then harvest the equity gains because of falling rates and actuals, this allowed even more property to be purchased... driving prices even higher ..... so the beast just kept feeding itself, fed on easy and cheap credit and low holding costs. And because rate cuts were so frequent across the 25 years , and holding costs fell with each rate reduction, this speculative approach rarely ever came undone for most investors. Average Joes and Josephine's could get 12 or even 15 x income easily if they wanted it, and hold it comfortably while they waited for the big pot of gold at the end of the CG rainbow ... which they were almost assured of because everyone else could also get 12-15 x income as well. It was the classic case of a rising tide lifting all boats.... and it lasted almost 3 decades. One might say the tide rose several times ;)

    Now though, we sit in a more regulated environment, where borrowing capacity has ceilings and where IO does have an impact , and where holding costs do increase.... and average Joes and Josephines are largely restricted to 6,7 or possibly 8 x income at a stretch.... and banks do eventually force them to start paying it off. And worse still...there are few ( if any) rate cuts left in the kitty... 1% at most... a far cry from the 14 or 15% in reductions over the past 25-30 years

    These are only the facts. There for all to see. And while APRA may have relaxed things at the margins recently , no honest person can claim the same ingredients are available today as were available until 2015 . So beware thinking you can simply bake the same cake with such different ingredients and expect the same outcomes/results .... One really has to question whether the growth trajectory of the future can replicate the growth trajectory of the past under such different conditions... and only hindsight will tell if it its possible I guess, but even if it can ( which I doubt very much) one also has to then question whether one can afford to hold long enough under P&I conditions to find out ...

    Knowing all of this....isn't there at least some merit in ensuring some of your portfolio carries sufficient cash flow to cater for these probabilities? I certainly think so.
     
    Last edited: 7th Sep, 2019
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  9. Codie

    Codie Well-Known Member

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    @euro73 lets go back even further (see attached) what caused growth back as far as 1970? still had double digit growth pre double income's and easy credit. From what I hear it wasn't common for households to own multiple properties yet prices still rapidly increased.

    Investors are hardly jumping in right now yet prices have rebounded and are increasing rapidly, I guess what I'm suggesting is owner occupiers that don't have multiple properties are mostly responsible for an increase in prices, not investors. And this segment will always drive the market

    If only 0.46% of the population own 3 or more, are people really maxing out on borrowing left right and centre? or just a very tiny % that has no affect on the market
     

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  10. John_BridgeToBricks

    John_BridgeToBricks Buyer's Agent Business Member

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    Good one Codie. The boom in real estate prices preceded deregulation (which was a good thing).

    Two things drove asset prices since the 1970s: 1) going off the gold standard in August 1971, which allowed central banks to print money; and 3) Baby Boomer demographics.
     
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  11. Codie

    Codie Well-Known Member

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    Further to this and has been discussed before I would suggest inflation actually has done most of the heavy lifting over the last 40 odd years. Yet it hardly gets taken into account.

    What's another 20yrs of inflation going to do to prices? My guess is still well up
     
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  12. Sackie

    Sackie Well-Known Member

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    Can almost guarantee you from now to 20 years time there will be some fantastic deals around Australia which will yield great profits. I for one, intend to seek them out and have a stab at it.
     
  13. euro73

    euro73 Well-Known Member Business Member

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    I agree that prices can grow. I havent ever suggested they cant. I just dont agree they can grow at the same speeds people have become used to , or that holding large portfolios under IO terms can be done for the duration... and that's why people need to factor in what they will do when they are required to carry debt on a P&I basis.

    If we want to rely on inflation to do the lifting, we need wage growth- which is nowhere to be found..... its yet another missing ingredient people don't have these days , yet believe they can still bake the same cake as those who had it... and besides- we wouldn't want to be using the last few quarters of inflation as our baseline .to support the argument for growth over the coming years ...if the last few quarters are any indication of whats to come, the numbers don't look like they're going to deliver much at all...
     
    Last edited: 7th Sep, 2019
  14. euro73

    euro73 Well-Known Member Business Member

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    deregulation commenced in the 1970's... I didn't say it started in 1990. I just used the 25 year period between 1990 and 2015 to demonstrate lender policies that evolved during that period to drive price growth. If we want to go back to the 70's, here's what happened /changed after 1971.

    1. The interest rates that banks could charge on loans and pay on deposits were controlled, and generally did not vary much. This effectively prevented banks from managing or, more specifically, expanding their balance sheets.
    2. Banks were subject to reserve ratios and liquidity ratios. These ratios were used by the authorities to control the second-round effects on bank balance sheets of exogenous flows of liquidity from either the balance of payments or fiscal policy.
    3. Banks were subject to directives on the overall quantity of loans and at times there was moral suasion in relation to the industries to which loans should or should not be made.
    4. Institutions were specialised: trading banks lent to businesses; savings banks lent to households, almost entirely for housing; and finance companies lent for more risky property loans and consumer credit.
    5. All transactions in foreign exchange were closely controlled, particularly capital transactions, which were individually approved. Australians by and large were not allowed to make portfolio investments offshore, mainly because the authorities wanted to preserve domestic savings for domestic investment.
    6. The exchange rate was managed very tightly. Australia did not join the many other developed economies that moved to a floating exchange rate after the breakdown of the Bretton Woods arrangements in the early 1970s.
    https://www.rba.gov.au/speeches/2007/sp-dg-160707.html



    The other point that's quite important is that while prices rose in the 70's and 80's before really easy credit and double income households, they did so from a very very very low price base. Take a look at household debt to income ratios right throughout the 1970's and 80's..... then look at the trend from @ the late 1990's and into the 21st century...where prices accelerated away from all rational DTI ratio's.

    Here's a look at the widening gap between wages and house prices

    People who are saying that growth of the past 3 decades will be repeated are asking us to accept that borrowers will be able to continue to borrow enough debt to pay prices that are increasingly higher multiples of income.... otherwise known as DTI ratios. The gap between income inflation and borrowing capacity inflation would need to continue to widen in order for that to happen. So we are being asked to agree or accept that this is plausible even when APRA's chairman has expressly stated that DTI ratios are not going to be allowed to return to previous levels... and that in fact he would prefer they were capped at 6 x income or something close to that level ... and we are being asked to accept this when wage inflation is basically non existent . These factors combine to create for me at least, a view that such bullish expectations are irrational and are unlikely to be met.

    If you look at the DTI ratios that existed prior to deregulatioin, where 3.5 x income was allowed.... and then look at the DTI ratio's we had reached in SYD and MEL before APRA, where SYD was somewhere in the 10.4 or 10.5 x income range, and for MEL it was somewhere approaching 9.5% from memory.... you can see there's been a massive expansion in DTI ratio's. This was achieved only because lender policies/ servicing calcs allowed it to be achieved. They won't now. DTI ratios now max out at no more than 7-8 x income at almost all lenders .... so while that remains the case, there just isnt any mathematical way a sustained return to boom like conditions can occur.

    This is a sugar hit at the moment . Its 3 months in. Its isolated to some suburbs in some cities. It is unlikely that it will sustain, although I have to be fair and concede we will really only know in a year or two ....but the maths are the maths, and current policies just dont cater for a sustained return to growth

    But.... this argument becomes a lot like politics - rusted on opinions cant really be moved. Those who advocate the growth cycles are back and that debt reduction or cash flow management isnt important wont ever be convinced otherwise.....so we should all just soldier on doing what we choose to do for our own personal circumstances . I can only say this; whatever happens growth wise, I hold a portfolio that delivers me a very comfy retirement either way. It self services and will pay itself down in less than 20 years whether growth doubles, triples or does nothing remotely close to either of those things . If I get zero growth and zero rental inflation I will retire with 25-30 K per month of income. If I get 50% rental inflation, add 50% to that figure . If rents double in that 20 years, double my results . And if prices collapse I still get a comfy retirement income.... because I can HOLD easily. If I become injured or ill or incapacitated tomorrow, I can HOLD easily. If all my loans migrated to P&I tomorrow, I can HOLD easily. Almost 2/3 of my debt is already P&I...

    I wonder how many investors here can say those things? I suspect the answer is not very many. Cash flow reinvested towards debt reduction means that I have all contingencies covered that are reasonably within my control. I of course WANT growth - who doesnt??? But I do not require it, need it or rely upon it in order to enjoy a very comfy retirement. I can just continue to dividend reinvest and I am assured of a wealthy retirement even if prices do nothing at all. How many investors can say that? I suspect that again, its not very many ..... So for those who DO rely, require or need growth to end up ahead, because their properties run at losses and will run at even bigger losses P&I , and who will increasingly fail to pay down their debts in their working lifetimes.... requiring that they make big profits to walk away with anything at all, what is the back up plan if the big pot of growth doesn't pay off ?
     
    Last edited: 8th Sep, 2019
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  15. MWI

    MWI Well-Known Member

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    I would add perhaps some double income households helped too!
     
  16. John_BridgeToBricks

    John_BridgeToBricks Buyer's Agent Business Member

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    True. I tend to see that as a response to point #1 (ie currency debasement in the 1970's). But good point.
     
  17. MTR

    MTR Well-Known Member

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    Bump

    I started this thread in 2016...... my how things have changed.

    Finance/lending environment a totally different beast. Much more difficult to source finance and servicing is far more stringent

    So how do we grow capital first today????
     
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  18. John_BridgeToBricks

    John_BridgeToBricks Buyer's Agent Business Member

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    I think in most markets, there has been minor capital growth since 2016, and most of that was 2016-2017.

    That said, I think anything you held in 2016 has since become cash flow positive by 2020 due to interest rate cuts.
     
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  19. Niche

    Niche Well-Known Member

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    Very interested to hear what people have to say about this.

    As a relatively new investor who only has 1 investment property plus PPR I feel like I am pretty limited in my next move to increase capital unless I get a decent salary increase (which is plausible) or I just have to wait until I have paid off a good chunk of my loans so I can borrow more.
     
  20. wombat777

    wombat777 Well-Known Member

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    Micro cap and small cap shares can be an effective way to grow capital. Careful strategy is required to manage risk. You need to do your research on company prospects/assets, management, management's plan etc, etc.

    If you can find elusive 5-bagger, 10-bagger, 50-baggers etc then gains can be life-changing. Spread risk through diversifying.

    People that are analytical and patient can do well.

    I started with a goal of building capital to use as equity for a development, but now I am thinking bigger picture.
     
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